Case 3: Outsourcing and offshoring

The case highlights one of the important topic of Managerial Economics, i.e. how decision
relating location of production are made.
Review
the
news
report
in
The
Economist
Welcome
home
(
http://www.economist.com/news/leaders/21569739-outsourcing-jobs-faraway-places-wane-willnot-solve-wests ) and the special report on Outsourcing and offshoring (
http://www.economist.com/news/special-report/21569572-after-decades-sending-work-acrossworld-companies-are-rethinking-their-offshoring ). Visit websites with articles on outsourcing.
Based on your review, please write a short paper of no more than 5 (five) typed pages that should
include:
1. What is the difference between outsourcing and offshoring?
2. What are the advantages and disadvantages of outsourcing?
3. What is reshoring? Why some companies are reshoring manufacturing in the United
States?
4. How Bangladesh can benefit from rising costs of production in China?
5. What are the challenges and opportunities for Bangladesh posed by reshoring of
manufacturing in developed countries?
PDF version of the news report and the special report published in the Economist.

Welcome home

The outsourcing of jobs to faraway places is

on the wane. But this will not solve the
Wests employment woes
Jan 19th 2013 |From the print edition

IDEALLY, said Jack Welch in 1998, when he was chief executive of General Electric, youd
have every plant you own on a barge to move with currencies and changes in the economy.
Reality followed vision for Mr Welch, who was a pioneer of offshoring, setting up one of the
first offshore service centres in Gurgaon on the outskirts of Delhi.

GEs line has now reversed. Jeff Immelt, Mr Welchs successor, calls outsourcing yesterdays
model. He has returned production of fridges, washing machines and heaters from China back
to Kentucky. Having shipped much of its IT work outside America, the conglomerate is now
shifting it back and taking on hundreds of IT engineers at a new centre in Michigan. And GE is
not alone. As our special report this week explains, bringing jobs back to the rich world is as
much in vogue these days as sending them to China was a decade ago.
In this section
How will history see me?
Dont give up
Get stuck in but dont get stuck
Welcome home
Dangerous shoals
The soldiers dangerous itch
Reprints
Related topics
Financial markets
BCG
General Electric
China
United States
This reversal is of political as well as economic significance. Fears of losing jobs to less-wellpaid workers overseas have battered many politicians. In last years American presidential
election Mitt Romney never recovered from early digs at his record of outsourcing and
downsizing at companies owned by a private-equity firm he helped found.
In truth, offshoring never had as direct or dramatic an impact on employment in America and
Europe as was widely believed. Lines of computer code and industrial robots have probably
displaced as many or more call-centre operators and factory workers as cheap Asian hands have
done. Until the economic crisis, employment levels held up well in the rich world. But the threat
of losing jobs overseas has exerted a powerful downward pressure on middle-class wages, and
offshoring has undermined support for globalisation.

Now the pull of low-wage countries is weakening. In a survey of big American manufacturers by
the Boston Consulting Group last spring, nearly two-fifths of firms said they were either
planning to move or thinking about moving production facilities from China back home. Next
month America will start making mass-market personal computers again when Lenovo, a
Chinese giant, relaunches production of IBM ThinkPad notebooks and desktop PCs in North
Carolina. Foxconn, a Taiwanese firm which makes a large share of the worlds electronic
gadgets, now says it will expand in America. General Motors plans to shift almost all its IT
(much of which had also gone to India) back home to Detroit. These days the main reason why
companies want to expand their presence overseas is to be close to consumers in fast-growing
new markets, not to exploit low wages as part of an offshoring strategy.
A shore story
The political mood may have influenced decisions to bring jobs back, but the fundamental
drivers are economic. First, manufacturing is becoming more automated, so labour makes up a
decreasing proportion of costs. Second, for businesses that continue to rely on armies of people,
labour costs have soared in formerly poor countries. Wages for Chinese manufacturing workers
are going up by around 20% a year, faster than their productivity is growing. A stronger Chinese
currency has added to the upward pressure on costs.
True, other countries, such as Vietnam and Bangladesh, are competing to take Chinas place as
low-cost havens. But these cannot replicate Chinas scale and supply chains. And companies are
increasingly factoring in the rising cost of shipping goods across oceans, and the risk that natural
disasters or geopolitical shocks could cut off essential supplies. Consultants at both BCG and
Alix Partners reckon that by 2015 it will cost about the same for an American firm to
manufacture in America as in China. Western firms are also finding that innovation is easier
when manufacturing is in the same place as research.
Offshoring in services is, to be sure, still going strong overall. But early pioneers of services
offshoring are bringing work back home, having discovered that looking after customers and
developing new IT tools are in fact a core part of business. For many firms, sending call
centres overseas has turned into a nightmare. We just cant get the accents right, confesses one
Indian outsourcing executive. As with manufacturing, the advantages of outsourcing services are
falling. For an American firm, the gap between the cost of employing an Indian software
programmer and the cost of a local one will fall to under 20% by 2015, predicts Offshore
Insights, a Pune-based advisory firm. All this could add up to the Death of Outsourcing, says a
paper by KPMG, whose consultants have long advised Western firms on sending work overseas.
These changes should discourage hostility to globalisation in rich countries, but they should not
encourage complacency. Reshoring may boost demand for labour, but only for high-quality,
well-educated workers. As skills increase in poorer countries, people in rich ones will find the
global labour market ever more competitive. The shift of jobs back to developed countries is an
encouraging sign that the flow of jobs need not be one-way. But only if governments and people
in prosperous places invest heavily in building up skills will the workforces there properly
benefit.

Here, there and everywhere

After decades of sending work across the

world, companies are rethinking their
offshoring strategies, says Tamzin Booth
Jan 19th 2013 |From the print edition

EARLY NEXT MONTH local dignitaries will gather for a ribbon-cutting ceremony at a facility
in Whitsett, North Carolina. A new production line will start to roll and the seemingly impossible
will happen: America will start making personal computers again. Mass-market computer
production had been withering away for the past 30 years, and the vast majority of laptops have
always been made in Asia. Dell shut two big American factories in 2008 and 2010 in a big shift
to China, and HP now makes only a small number of business desktops at home.
The new manufacturing facility is being built not by an American company but by Lenovo, a
highly successful Chinese technology group. Founded in 1984 by 11 engineers from the Chinese
Academy of Sciences, it bought IBMs ThinkPad personal-computer business in 2005 and is now
by some measures the worlds biggest PC-maker, just ahead of HP, and the fastest-growing.
Special report
Here, there and everywhere

The story so far

Coming home
Staying put
Herd instinct
On the turn
The next big thing
Rise of the software machines
Shape up

Sources & acknowledgmentsReprints

Related topics
Europe
Lenovo
General Electric
India
Business
Lenovos move marks the latest twist in a globalisation story that has been running since the
1980s. The original idea behind offshoring was that Western firms with high labour costs could
make huge savings by sending work to countries where wages were much lower (see article).
Offshoring means moving work and jobs outside the country where a company is based. It can
also involve outsourcing, which means sending work to outside contractors. These can be either
in the home country or abroad, but in offshoring they are based overseas. For several decades
that strategy worked, often brilliantly. But now companies are rethinking their global footprints.

The first and most important reason is that the global labour arbitrage that sent companies
rushing overseas is running out. Wages in China and India have been going up by 10-20% a year
for the past decade, whereas manufacturing pay in America and Europe has barely budged. Other
countries, including Vietnam, Indonesia and the Philippines, still offer low wages, but not
Chinas scale, efficiency and supply chains. There are still big gaps between wages in different
parts of the world, but other factors such as transport costs increasingly offset them. Lenovos
labour costs in North Carolina will still be higher than in its factories in China and Mexico, but
the gap has narrowed substantially, so it is no longer a clinching reason for manufacturing in
emerging markets. With more automation, says David Schmoock, Lenovos president for North
America, labours share of total costs is shrinking anyway.
Second, many American firms now realise that they went too far in sending work abroad and
need to bring some of it home again, a process inelegantly termed reshoring. Well-known
companies such as Google, General Electric, Caterpillar and Ford Motor Company are bringing
some of their production back to America or adding new capacity there. In December Apple said
it would start making a line of its Mac computers in America later this year.
Choosing the right location for producing a good or a service is an inexact science, and many
companies got it wrong. Michael Porter, Harvard Business Schools guru on competitive

strategy, says that just as companies pursued many unpromising mergers and acquisitions until
painful experience brought greater discipline to the field, a lot of chief executives offshored too
quickly and too much. In Europe there was never as much enthusiasm for offshoring as in
America in the first place, and the small number of companies that did it are in no rush to return.

Firms are now discovering all the disadvantages of distance. The cost of shipping heavy goods
halfway around the world by sea has been rising sharply, and goods spend weeks in transit. They
have also found that manufacturing somewhere cheap and far away but keeping research and
development at home can have a negative effect on innovation. One answer to this would be to
move the R&D too, but that has other drawbacks: the threat of losing valuable intellectual
property in far-off places looms ever larger. And a succession of wars and natural disasters in the
past decade has highlighted the risk that supply chains a long way from home may become
disrupted.
Third, firms are rapidly moving away from the model of manufacturing everything in one lowcost place to supply the rest of the world. China is no longer seen as a cheap manufacturing base
but as a huge new market. Increasingly, the main reason for multinationals to move production is
to be close to customers in big new markets. This is not offshoring in the sense the word has
been used for the past three decades; instead, it is being onshore in new places. Peter Lscher,
the chief executive of Siemens, a German engineering firm, recently commented that the notion
of offshoring is in any case an odd one for a truly international company. The home shore for
Siemens, he said, is now as much China and India as it is Germany or America.
Companies now want to be in, or close to, each of their biggest markets, making customised
products and responding quickly to changing local demand. Pierre Beaudoin, chief executive of
Bombardier, a Canadian maker of aeroplanes and trains, says the firm used to focus on cost
savings made by sending jobs abroad; now Bombardier is in China for the sake of China.

Lenovo, as a Chinese company, has its own factories in China. The reason it is moving some
production to America is that it will be able to customise its computers for American customers
and respond quickly to them. If it made them in China they would spend six weeks on a ship,
says Mr Schmoock.
Under this logic, America and Europe, with their big domestic markets, should be able to attract
plenty of new investment as companies look for a bigger local presence in places around the
world. It is not just Western firms bringing some of their production home; there is also a wave
of emerging-market champions such as Lenovo, or the Tata Group, which is making Range
Rover cars near Liverpool, that are coming to invest in brands, capacity and workers in the West.
Such changes are happening not only in manufacturing but increasingly in services too.
Companies may either outsource IT and back-office work to other companies, which could be in
the same country or abroad, or offshore it to their own centres overseas. Software programming,
call centres and data-centre management were the first tasks to move, followed by more complex
ones such as medical diagnoses and analytics for investment banks.
As in manufacturing, the labour-cost arbitrage in services is rapidly eroding, leaving firms with
all the drawbacks of distance and ever fewer cost savings to make up for them. There has been
widespread disappointment with outsourcing information technology and the routine back-office
tasks that used to be done in-house. Some activities that used to be considered peripheral to a
companys profits, such as data management, are now seen as essential, so they are less likely to
be entrusted to a third-party supplier thousands of miles away.
Coming full circle
Even General Electric is reversing its course in some important areas of its business. In the 1990s
it had pioneered the offshoring of services, setting up one of the very first captive, or fully
owned, offshore service centres in Gurgaon in 1997. Up until last year around half of GEs
information-technology work was being done outside the company, mostly in India, but the
company found that it was losing too much technical expertise and that its IT department was not
responding quickly enough to changing technology needs. It is now adding hundreds of IT
engineers at a new centre in Van Buren Township in Michigan.
This special report will examine the changing economics of offshoring in the corporate world. It
will show that offshoring in its traditional sense, in search of cheaper labour anywhere on the
globe, is maturing, tailing off and to some extent being reversed. Multinationals will certainly not
become any less global as a result, but they will distribute their activities more evenly and
selectively around the world, taking heed of a far broader range of variables than labour costs
alone.
That offers a huge opportunity for rich countries and their workers to win back some of the
industries and activities they have lost over the past few decades. Paradoxically, the narrowing
wage gap increases the pressure on politicians. With labour-cost differentials narrowing rapidly,
it is no longer possible to point at rock-bottom wages in emerging markets as the reason why the
rich world is losing out. Developed countries will have to compete hard on factors beyond labour

costs. The most important of these are world-class skills and training, along with flexibility and
motivation of workers, extensive clusters of suppliers and sensible regulation.